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Revisiting Inflation, Unemployment, and Policy

Phillips Curve and Supply Shocks


Shifting the Phillips Curve:Supply Shocks

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now, let's see how a shift in our short run aggregate supply is going to affect our phillips curve. So when we talk about shifts in our short run aggregate supply, its due to something called a supply shock. It's some sort of unexpected event that affects a firm's production cost and shifts the aggregate supply curve. Okay, so we're gonna be shifting our aggregate supply curve either left or right. Generally, when we talk about a supply shock, it's usually something like input prices have increased. Okay, so something like input prices like gasoline have unexpectedly increased. So there's some shortage of gasoline and now prices are much higher for gasoline. A lot of a lot of products use gasoline to uh firms use gasoline to create their product. Uh so the input prices are higher in that case. So let's go with that example here and let's see what happens in the short run phillips curve when we have this supply shock. Okay, so a sudden increase in gas prices affects the input prices of firms production. So this is the supply shock right here. This is an unexpected increase in in the input price. Okay, it could also be an unexpected decrease. Now there's a bunch of gasoline available and there's a decrease, but generally when you see this, it's gonna be a situation where there's an increase. Okay, so higher input prices, that's bad for supply, right? That's a bad thing for supply. So, if we go down to R. A. D. A. S. Model, our supply curve would be shifting to the left, We would have a shift to the left due to this supply shock. So S. R. A. S. One short run aggregate supply would shift to S. R. A. S. To remember that here we have our price level and our GDP and in the short run phillips curve we've got inflation rate, an unemployment rate. Okay, let me get out of the way here. All right, so we have this shift to the left in our short run aggregate supply. So what does this do notice we had this original equilibrium right here at this original equilibrium? Well we had this level of GDP let's say it was um right here we'll just call it g. d. p. one And price one and it scoots up to this new point right at this new equilibrium. Um And we have less GDP right? There's less G. D. P. And higher prices. This sounds doubly bad, right? This sounds like a double bad thing happening in the economy. Right? So this is more inflation and more unemployment. Right? So over here I'm gonna write more unemployment right? Because if there's lower G. D. P. That means there's less people employed to create the output in our society. So there's more unemployment they don't need as many workers to at this level of GDP so we have two bad things. We have more inflation and more unemployment. That's doubly bad. So what how that affects our short run phillips curve will remember our short run phillips curve looks something like this. So our short run phillips curve might have looked something like this I'll say pc for phillips curve one. Well now at any level we have higher inflation and higher unemployment rate. So this is shifting our phillips curve to the right and we're gonna be in a situation we're at any level we're gonna have a higher um higher unemployment and higher inflation. So a decrease in aggregate supply leads to a shift to the right in our let me make that fit a shift to the right in our short run phillips curve. Okay so it's doubly bad when we have a supply shock that shifts our aggregate supply to the left. Well both unemployment and inflation increase. So we're gonna see that short run phillips curve shift to the right. Okay so an aggregate supply decreases, we see output decrease in the price level increase. So this leaves the policy policymakers in a difficult position right now they have to fight both higher inflation and higher unemployment at the same time. So they're fighting both high inflation and high unemployment. So that makes it much more difficult. Remember there's always gonna be this trade off if we try and decrease our unemployment. Well inflation is gonna pop up even higher right if we try and mitigate the inflation. Well we're gonna have even worse unemployment. Alright so that's the that's the the double double jeopardy that we get put in when we have um a shift, a supply shock and a and a downward shift in our aggregate supply. Cool. Let's go ahead and move on to the next video.